ECON CH34: Monetary Policy

federal reserve goal

promote maximum employment, while keeping inflation low and stable

directly change

The Fed cannot _____ _____ inflation or employment.

monetary policy

the process of setting interest rates in an effort to influence economic conditions

induces people to spend less today

fed raises interest rates

induces people to spend more today

fed lowers interest rates

equal

Dual mandate achieved when actual output is ____ to potential output.

check

As an independent government agency, the Federal Reserve acts as a ____ for fiscal policy.

president, US senate

Board governors of the Fed are selected by the _____ and confirmed by the _____.

decide on US interest rates

goal of the Federal Open Market Committee

forecasts, policy choices and communication

What do the Fed talk about in these meetings?

forecasts

everyone shares their views on current economic conditions, as well as their short and long term predictions for the economy

policy choices

raise or lower the real interest rate? by how much? over what time period?

fedspeak

a communication style that relied on intentionally vague and bureaucratic language

communication

convince people the Fed will follow through and achieve its goals; shape expectations

stable prices

achieved when inflation is near or at the Fed’s inflation target (2%)

virtuous cycle

if people believe inflation will be low and stable, price increases will be small and inflation remains low and stable

easily targeted

Inflation is ____ _____ by monetary policy.

maximum sustainable employment

Hitting the inflation target also promotes _____ _____ _____.

high unemployment

the economy is operating with excess capacity → inflation rate declines below Fed’s target

low unemployment

the economy will hit its capacity constraint → inflation rate rises above Fed’s target

labor market

Inflation greases the wheels of the ____ ____.

quietly cut real wages

Employers often find it difficult to cut nominal wages, but with 2% inflation, they can ________ by simply not giving that employee a raise.

lay off more workers than otherwise would

potential result of zero inflation

zero lower bound

the Fed cannot set nominal interest rates below zero

overstated

Don’t target zero inflation because the measured inflation may be _____.

the neutral interest rate

when the economy is not operating above nor below its potential

the nominal interest rate

the Fed uses this to influence the real interest rate

real interest rate + inflation

nominal interest rate equation

gap, target

Use the ___ between inflation and the _____ inflation rate to assess how to change the real interest rate.

outputs

use the gap between _____ to assess whether the fed should take steps to cool or stimulate the economy.

higher

If inflation is higher than the target, Fed set real interest rates ____ than the neutral interest rate.

lower

If inflation is lower than the target, Fed set real interest rates ____ than the neutral interest rate.

higher

If actual output exceeds potential, Fed set real interest rates ____ than the neutral interest rate.

lower

If actual output is lower than potential, Fed set real interest rates ____ than the neutral interest rate.

federal funds rate - inflation = neutral interest rate + 1/2(inflation - 2%) + output gap

fed rule of thumb equation

reserves

the cash that banks need to keep on hand to make payments

demand for funds

sometimes banks do not have enough ready cash to make payments on a given day

supply for funds

other banks may have more cash on hand than they need

the price

the forces of supply and demand determine the interest rate changed on these overnight loans

minimum

The Fed pays interest on reserves, which creates a ______ interest rate that banks will charge before loaning funds overnight.

increases, higher

When the Fed engages in overnight borrowing as a demander, _____ demand for overnight loans and leads to ____ interest rates.

floor framework

the Fed pays interest to banks on their reserves and borrows from financial institutions overnight and pays them interest on the loan

the discount rate

the interest rate that the Fed offers through the discount window, typically higher than the federal funds rate → acts as an upper bound

collateral

Banks offer _____ and get a loan from the Fed that helps them meet their reserve requirement.

increases, decreases

When the fed sells bonds, ____ demand for overnight loans and _____ supply.

reserves, supply

After buying bonds, the money is taken from the bank’s reserve, leading the bank to be more likely to borrow ____ and less likely to be able to ____ them to other banks.

forward guidance

providing information about the future course of monetary policy in order to influence market expectations of future interest rates

quantitative easing

the fed’s strategy of purchasing large quantities of longer-term government bonds and other securities in an effort to put downward pressure on long-term interest rates, including mortgages

forward guidance, quantitative easing

______ and ______ both aim to push interest rates below zero.

the lender of last resort

Fed as the place financial institutions turn to when they need cash right away, but they are having trouble getting a loan elsewhere → prevent widespread bank runs, business failures and general financial panic